With inflation showing signs of slowing down, the next issue taking centre stage is the government's rising fiscal deficit. Failing to stick to its target of bringing it down to around 4.6% of GDP in FY12, the government is looking at all possible avenues to bridge the gap. The ambitious divestment program was touted to ease considerable pressure off the Centre but with market conditions proving to be volatile, stake sales so far have been a damp squib. And in mounting desperation, the government is now looking to milk the cash rich PSUs by making them dole out higher dividends.

All of which has not done much to allay the fears of investors. As Bloomberg reports, the cost of protecting against default in India is surging to a three-year high as investors bet that the government will fail to rein in the nation's budget deficit. With revenue sources drying out, government expenses have not really been cut down as subsidy payments have risen. Meanwhile, the Finance Minister, Mr Pranab Mukherjee, has expanded the government's debt- sales program for the fiscal year by 8.5% to a record Rs 5.1 trillion (approx. US$ 101 bn) last month, to bridge the shortfall in revenue. Further, given that the confidence of the investors is ebbing, the government will have to shell out more as interest. For instance, investors are demanding an extra yield of 635 basis points to hold the 10-year notes over similar- maturity US Treasuries. This will only pile on the pressure on the government in terms of reducing costs.

In the event of what we have seen in Europe and the US, where governments are struggling to stay afloat after debt has ballooned, the Indian government cannot afford to take this matter lightly. Pushing PSU companies to give more dividends is only a short term solution to a more chronic long term problem. More emphasis will have to be laid on streamlining subsidies and cutting down overall non-developmental expenditure, so that there is more headroom to spend on activities that have the potential to contribute to India's GDP growth. Otherwise, the problem of rising fiscal deficit will only keep popping up as a regular thorn on the government's side. This then would certainly have a negative impact on Indian stock markets, as investors (both foreign and Indian) looking for some meaningful policy making by the government, find that it is not quite serious about resolving this issue at the earliest.

Do you think that the government will be able to bring its fiscal deficit under control going forward? Let us know your comments or post them on our Facebook page / Google+ page.

01:28

Chart of the day

Today's chart of the day shows that India had the worst current account position in 2011 as compared to its peers both in the developed and developing world. Given that India's trade account has been running into a deficit, the same has had an impact on the overall current account deficit as well. The country's trade deficit has widened largely on account of rising prices of petroluem, gold and silver, which account for a significant chunk of its import bill. Although the rupee depreciating against the dollar should bridge this gap to a certain effect, the change has not been significant uptil now. Meanwhile other BRIC nations (i.e. China, Brazil and Russia) have fared better than India on this front.

Data source: The Economist

02:08

According to you, which is the most likely place to witness scenes of entrepreneurs committing suicides and fleeing their motherland in droves? Greece? Portugal? US? China could possibly be the last name on your list. After all, a country having one of the fastest growing economies in the world does not give too many reasons for its entrepreneurs to take their own lives. Unfortunately though, these unsavoury episodes are taking place with constant regularity in the dragon nation. And this makes us wonder whether there is more to the China story than what meets the eye. If a story on Firstpost.com is to be believed, there certainly is.

You see, the problem with China is not liquidity. We believe that there is too much of it sloshing around. The real problem is misdirected investments and that too in amounts that we cannot even contemplate. And to make matters worse, China's key destinations for its tremendous manufacturing capacity, the US and Europe are battling a significant slowdown of their own.

Thus, not only will China have to rely a lot more on consumer within its shores but also go slow on its investments. And these measures could be anything but a walk in the park. While the former is likely to take some time, the latter would mean reducing employment opportunities for people and thus giving an open invitation to social unrest. A hard landing thus looks more and more likely with each passing day. The timing of the same however is an impossible thing to predict.

02:55

One major reason why every effort of the Indian government to rein in the trade deficit has gone out of the window in 2011 is gold. Indian's obsession with the precious yellow metal and the sharp depreciation of rupee versus the US dollar ballooned India's import bill in 2011. Ever since the attractiveness of the yellow metal grew in reciprocation to the chaos and crisis in the global economy, Indians have found their calling in gold as an investible asset class.

As per World Gold Council, India's gold imports rose 60% year-on-year (YoY) in 2011. Further, gold imports have gone up nearly 0.5% of the GDP in the last three years. However, the government may not let this party continue at the cost of fiscal and budgetary imbalances. Since India imports nearly all its gold requirement, excessive import of the metal could lead to compromises on other necessary commodities. Hence, the government has announced a change in the import duty on gold to 2% of value from the earlier flat charge of Rs 300 per 10 grams. While this will certainly push the price of the metal further upwards, it will also help the government cash in on the gold bull run.

03:41

What is it that drives financial markets in the short term? The answer is news. In recent times, there has been some positive sentiment surrounding the US economy. But renowned economist Nouriel Roubini has some bad news. And what is the bad news? The bad news is that the good news is not true. In his words, "US consumers remain income-challenged, wealth-challenged, and debt-constrained." Whatever little rise there has been in real disposable income has been the result of tax cuts and transfer payments. But this is certainly not sustainable. In order to fix the fiscal deficit, the government will have to raise taxes sooner or later. The rate of job growth in the US is too meagre to make much difference. Even worse, 40% of the unemployed people are now long-term unemployed. As per Roubini, the rising income inequality will further hinder consumption growth. All in all, the fate of the US economy will now be a tug-of-war between the negative factors such as huge fiscal and trade deficit, high unemployment, excess debt and the positives such as a global reserve currency, high productivity, technology and free-market economy.

04:16

During the real estate boom where valuations were linked to land bank, many developers went over board and piled up huge debt on their books to buy land parcels. But now when liquidity is hard to come by, these very developers are offloading land parcels to meet their debt repayment obligations. This has presented a unique bargain opportunity to low debt-cash rich developers to buy land at reasonable prices. Further, considering that majority of the real estate players are stuck with inventory pile up (cash strapped) or are facing execution issues in finishing their projects, the interest to bid for the upcoming land parcels is also low. Only regional companies having a sound liquidity profile and low debt are in a better position to time the current downturn to their advantage. Take the case of Oberoi Realty or Peninsula Land for example. These companies are most active in the property markets right now and are scouting for lucrative land deals in an environment where the realty biggies are struggling. Thus, we believe it was conservatism and prudence that helped smaller companies sail the current downturn with ease.

04:47

In the meanwhile, the Indian stock market continued to trade near the dotted line. At the time of writing, the benchmark BSE Sensex was trading marginally down by 10 points (0.06%). Sectoral indices were trading mixed led by oil & gas space. Reliance Industries and Hero Motocorp were seen gaining the most amongst blue chips. Major Asian indices performed mixed today with stock market from Japan leading the pack of gainers while China stock market losing the most.

A brand new initiative of Equitymaster, this is the Premium version of our daily e-newsletter The 5 Minute WrapUp.

Join us in this journey to uncover the sensible way of managing money and identifying investment opportunities across various asset classes including Stocks, Gold, Fixed Deposits... that over time can help you realize your life's goals...

The government has limited options, of these there are few that government can decide to implement. The rest government will not take chances due to opposition from its allies, opposition party, and the organised unions of PSU's. So it will not be able to contain the fiscal deficit, as it does not have a free hand to deal with this problem.

I think the method of computation of current account deficit is not uniform between the countries. One of the main reasons for the high current account deficit is import of gold, which is mostly unproductive. At least now, the govt has initiated some action.Can the govt not think of some innovative incentive to bring out private gold held in vaults and make productive use of the same instead of further imports.

As the Indian economy is growing at a nominal rate of over 15% and the debt/ GDP is only about 60% the debt/GDP will decline unless the deficit is greater than10%. This is a non issue. Of course that does not mean that wasteful expenditure should no be controlled. Either way we should not be compared to slow growing economies. All the more reason we should focus on growth and not try and use high interest rates to control inflation. High growth is the best way to reduce the debt/GDP. Inflation will reduce when China slows down and forces global commodity prices down. The RBI has no influence on global commodity prices as such but it can control Indian prices by keeping the Rupee strong. Please do not be alarmist without looking at the numbers. Similarly the Current Account deficit is of no concern because the precious metl imports, which are available and not consumed, are about as large as the deficit. Bad commentary makes people nervous and sabotages the economy. Do not make treasonous comments!

Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement

Disclosure & Disclaimer: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. The Author does not hold any shares in the company/ies discussed in this document. Equitymaster may hold shares in the company/ies discussed in this document under any of its other services.

This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) be reproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without the consent of Equitymaster.

This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject Equitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent or has reached any individual in such country, especially, USA, the same may be ignored.

This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Our research recommendations are general in nature and available electronically to all kind of subscribers irrespective of subscribers' investment objectives and financial situation/risk profile. Before acting on any recommendation in this document, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The price and value of the securities referred to in this material and the income from them may go down as well as up, and subscribers may realize losses on any investments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness or accuracy. The views/opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. This document should not be construed as an offer to sell or solicitation of an offer to buy any security or asset in any jurisdiction. Equitymaster and its affiliates, its directors, analyst and employees will not be responsible for any loss or liability incurred to any person as a consequence of his or any other person on his behalf taking any decisions based on this document.

As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.